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On Austrian Business Cycle

This is not a topic I would normally write about. In particular, because I do not think Hayek was a particularly relevant theorist, even within the mainstream. By the way, that's the reason why within the neoclassical/marginalist school Austrians are sort of marginal. Note that marginal means that they are in the minority, but by no stretch of the imagination Austrians should be seen as heterodox [this is prove that Wikipedia, if you have doubts, is not entirely reliable. Again proper definition of heterodoxy means accepting that distribution is exogenous, and prices do not reflect relative scarcities, and that output and employment are demand determined in the long run, both positions that the Austrians would not accept].

But I got a few questions about Austrians and I think it is important to make one thing clear about their theory of business cycle, namely: it is not particularly different than mainstream theories, and is fundamentally Wicksellian in outlook, whether Austrians get it or not. There should be little doubt that Hayek believed that fluctuations were caused by monetary shocks, and that equilibration was based on the adjustment of a monetary rate to a natural rate [Remember his debate with Sraffa? One of the key issues in Sraffa's critique of Hayek was that he argued that latter's claim that the possibility of a difference between own rates of interest and thus a divergence of some rates from the equilibrium or natural rate is a characteristic of a money economy that is absent in a barter economy was simply wrong since there was no unique natural rate of interest from which the money rate could differ].

Even if you add his stuff on uncertainty, which many believe is close to post-Keynesian analysis, there is little in Hayek that departs from the basic Wicksellian framework [interestingly the Keynes of the Treatise shares that framework]. I should mention here that if you read Paul Davidson carefully, you would note that his concerns about fundamental uncertainty are basically related to lack of demand. When he tells you that firms do not hire workers for a lower wage unless they have demand, that means that government spending can reduce uncertainty very swiftly.

The only interesting Austrian is probably Schumpeter. Schumpeter, in contrast to Hayek, and like Wicksell, believed in real shocks, not monetary ones. Mind you, he was more interested in the sort of long term shocks caused by innovation. Still the framework is very similar, and Wicksellian in the fundamentals. Real shock (innovation) causes the spark for growth, diffusion eventually erodes the advantages of the innovators and the boom winds down. The economy moves from one circular flow, with the economy in Walrasian equilibrium to another one. So Schumpeter too is at core part of the marginalist tradition, as all Austrians are.

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Yes, all Austrians are at core part of the neoclassical/marginalist tradition. It's amazing they can't see this themselves. Paul Davidson lays out some details in "The Economics of Ignorance or Ignorance of Economics?" Critical Review, Vol. 3, No. 3-4, 1989, pp. 467-487.

One another point, perhaps in some future post you could explain this sentence which is too dense from me. "One of the key issues in Sraffa's critique of Hayek was that he argued that latter's claim that the possibility of a difference between own rates of interest and thus a divergence of some rates from the equilibrium or natural rate is a characteristic of a money economy that is absent in a barter economy was simply wrong since there was no unique natural rate of interest from which the money rate could differ"

Very briefly, I'm off to Chile. Hayek said that cycles were a monetary phenomenon since the difference between the money rate of interest and the natural rate of interest could not take place in a barter economy. Sraffa used the concept of own rate of interest to show that in fact in a barter economy there are several rates of interest (cycles didn't result from the difference of between rates of interest, although that is not discussed by Sraffa).

Mises made this point in 1932. As I'm sure you know, many contemporary Austrians claim that the Austrians and Neoclassicals diverged after that. But the divergence is no more than an internal family squabble. It's time for the current generation of Austrians to stop pretending that they are not Neoclassical.

"Within modern subjectivist economics it has become customary to distinguish several schools. We usually speak of the Austrian and the Anglo-American Schools and the School of Lausanne. Morgenstern’s work,11 which you have before you, has said almost all that is necessary about the fact that these three schools of thought differ only in their mode of expressing the same fundamental idea and that they are divided more by their terminology and by peculiarities of presentation than by the substance of their teachings."

I cannot claim to know the current debates within the Austrian School, but sure enough both Mises and Hayek were very clear that they followed on the steps of Menger and Böhm-Bawerk, which were part of the Marginalist Revolution. But the point is that even if they did not understand that, still you can analyze their theories. If it is based on the principle of substitution, in which relative prices are based on relative scarcities then it must be marginalist. If it walks like a duck and quacks like a duck, it is probably a duck.

Even Menger tried to disown Bohm-Bawerk's theory of capital. Schumpeter claims that Menger once told him that "[t]he time will come when people will realize that Bohm-Bawerk's theory is one of the greatest errors ever committed." (History of Economic Analysis, p.847, fn.9)

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